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CONDUCT OF BUSINESS: BUSINESS CUSTOMERS, CLIENT CLASSIFICATION AND THE CDRS

Invitation to comment

The QFC Regulatory Authority (“Regulatory Authority”) seeks public comments on its proposals to amend:

athe definition of business customer in Part 1.2 of its Conduct of Business Rules 2007 (“COND”);

baspects of the client classification requirements in Part 2.3 of COND; and

caspects of Chapters 2 and 8 of COND relating to the CDRS.

These proposals support the Regulatory Authority’s ongoing commitment to meet high international regulatory standards for financial services and the continued development of the QFC as a leading financial and business centre in the Middle East.

Proposals on client classification

3.1Jurisdictions that distinguish between different categories of customer also often provide a mechanism to allow a customer (whether an individual or legal entity) to be re-classified if certain criteria are met, usually based on a measure of the customer’s financial strength, knowledge and experience.

3.2Under the current COND rules, a retail customer can be re-classified subject to:

athe customer having USD 1 million in liquid assets or otherwise being an employee of an authorised firm or other regulated financial institution; and

bthe authorised firm being satisfied that the customer has sufficient knowledge, experience and understanding of relevant financial markets. The firm must take a number of factors into consideration when making this assessment.

3.3These current requirements were established in 2005 and have not been materially amended since that date. During this time a number of practical issues have arisen in the interpretation and application of the requirements. Amongst the more important of these issues are:

awhether legal entities that are technically captured by the definition of retail customer under the rules can be re-classified as business customers;

dareas where the rules are ambiguous or lack clarity (for example, the rules apply the knowledge and experience test to 'relevant financial markets', but not products or transactions).

3.4In order to resolve these issues under the current COND rules, the Regulatory Authority is proposing the following amendments.

How legal entities can be re-classified

3.5Under current rules there is uncertainty as to how the test should be applied to re-classify a legal entity as a business customer where the financial, knowledge and experience criteria are met. Specifically, the issue relates to whom the test should apply, for example the legal entity itself or the individual or individuals authorised to execute the transactions on behalf of the legal entity.

3.6To address this issue, the Regulatory Authority is proposing to:

aclarify that the knowledge and experience test applies to the individual or individuals authorised to make the transactions on behalf of the legal entity; this is in line with the relevant EU precedent on which the COND rules are based; and

ballow a legal entity to be re-classified as a business customer if a related person of the entity (such as its parent or controller) meets the criteria. The inability to do this in the QFC has caused some problems in the past: for example, situations where an underlying customer (who may be the parent or controller of the firm) has had difficulty undertaking transactions through an SPV as the SPV has been deemed the 'customer' and fails to meet the criteria to be classified as a business customer.

Financial criteria

3.1The current financial criteria for re-classifying customers, whether an individual or legal entity, is set at USD 1 million in liquid assets. This is a different approach to that commonly found in regimes that allow for customer re-classification. The liquid asset test has also proven difficult to define, excludes certain prominent asset classes, such as investment properties, and takes no account of the customer’s liabilities. The Regulatory Authority is therefore proposing to amend the criteria to a net asset test that is in closer alignment to the one found in other jurisdictions that have customer re-classification regimes. It is proposed to set the net asset test at QAR 4 million (subject to the exclusion of the primary family residence as an asset, although liabilities on this residence must be included).[1]

3.2The new test would only apply to classifications that take place from the commencement date of the amendments. All previous classifications made on the basis of the liquid assets test would remain valid.

Evidencing the financial criteria

3.3Evidencing the financial criteria in relation to individuals has proven problematic under the current rules. Publicly available information is generally limited and customers in the region tend to be reluctant to provide copies of detailed financial information. Accordingly, the evidence required for firms to comply with the rule is uncertain, open to interpretation and ambiguous.

3.4To address this issue, the Regulatory Authority is proposing that:

ain the first instance, the authorised firm must make reasonable steps (including obtaining detailed financial information from the customer and assessing publicly available information) to obtain sufficient evidence that the customer meets the net asset test;

bin the event that the firm, despite making documented reasonable efforts, has not been able to obtain this detailed evidence, it can rely on the individual's written confirmation that their net asset position meets the criteria.

3.5Where an authorised firm relies on the customer's statement, this must be in writing and on a form prepared by the firm, which includes a mandatory warning that mis-representing their financial position could be detrimental to the individual.

3.6An authorised firm, however, would not be permitted to classify an individual as a business customer where there are any reasonable doubts regarding the accuracy of an individual's statement.

3.7To address concerns that these individuals may be exposed to greater risks, the Regulatory Authority is proposing that the retail protections in Part 4.3 of COND relating to understanding the customer’s needs (‘know your customer’), suitability and risk assessments, would apply to all individuals who have been re-classified as business customers.[2]

Miscellaneous

3.8Finally, the Regulatory Authority has included a number of minor amendments that will not materially affect authorised firms, but will improve the policy outcome of the COND rules. These amendments either:

aclarify or strengthen a rule’s intention (for example, applying the knowledge and experience test not just to ‘relevant financial markets’, but to ‘relevant financial products, transactions or financial markets’);

bamend a rule to remove redundant material (for example, removing the option to re-classify a retail customer as a commercial customer as this concept applies to general insurance where the need to re-classify customers is unnecessary given the conduct requirements are far less prescriptive); or

cadd guidance to assist firms with complying with a rule (for example, how to disclose certain information to re-classified customers).

[1]The figure of 4 million reflects rounding up when converting figures from USD to QAR.

[2]These rules are located specifically in Division 4.3.A of COND. This requirement would also begin to apply to individuals re-classified prior to the commencement of these proposals, that is, before 1 January 2016.

The Consultation Paper invites comments on the proposed Conduct of Business Amendments Rules 2015 (“draft Rules”) as set out in Attachment 1. To assist readers, Attachment 2 shows the relevant parts of COND with the amendments tracked into the rules.

Click here to view PDF Version of Consultation Paper 2015/3.Click here to view Word Version of Consultation Paper 2015/3.

Click here to view PDF Version of Attachment 1 to Consultation Paper 2015/3.Click here to view Word Version of the Attachment 1 to Consultation Paper 2015/3.

Click here to view PDF Version of Attachment 2 to Consultation Paper 2015/3.Click here to view Word Version of the Attachment 2 to Consultation Paper 2015/3

In accordance with its statutory objectives, it is the Regulatory Authority’s policy to make all responses to formal consultation available to the public. Respondents who would like their submission, or parts of it, to remain confidential should provide this information marked as confidential. A standard confidentiality statement in an e-mail message will not be regarded as a formal request for non-disclosure.

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